The correct answer is: D. Both B and C
Profitability Index (PI) is a project selection method that compares the present value of the project’s cash inflows to the initial investment. It is calculated by dividing the project’s NPV by its initial investment.
A divisible project is a project that can be taken in parts. For example, a construction project can be divided into different phases, each of which can be completed independently.
When PI is applied to divisible projects, it implicitly assumes that:
- The NPV of the project is linearly proportionate to the part of the project taken up. This means that if we take up half of the project, the NPV will be half of the NPV of the entire project.
- The NPV of the project is additive in nature. This means that if we take up two projects, the NPV of the two projects will be the sum of the NPVs of the individual projects.
These assumptions are not always realistic. For example, the NPV of a project may not be linearly proportionate to the part of the project taken up. This is because some projects may have economies of scale, which means that the NPV per unit of output decreases as the scale of the project increases.
Similarly, the NPV of a project may not be additive in nature. This is because some projects may have interdependencies, which means that the NPV of one project may be affected by the decision to take up another project.
Despite these limitations, PI is a useful project selection method for divisible projects. It is simple to calculate and easy to understand. It also takes into account the time value of money.